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The Dynamics of Price and Advertising as Signals of Quality

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Abstract

A monopolist introduces a new product of either low or high quality. It advertises to make consumers aware of the product and signals product quality using both price and advertising. When consumption does not re- veal product quality, price is higher and advertising is lower than they would be if product quality is observable. Price rises and advertising falls as the fraction of aware consumers increases. When consumption reveals product quality, price is higher and advertising is lower than they would be if prod- uct quality is observable. Price declines as the fraction of aware consumers increases and advertising follows an inverted U shape. We ¯nd support for these empirical predictions from a data set on Direct-to-Consumer advertis- ing on pharmaceutical drugs.

Suggested Citation

  • Musa Ayar, 2007. "The Dynamics of Price and Advertising as Signals of Quality," University of Western Ontario, Economic Policy Research Institute Working Papers 20074, University of Western Ontario, Economic Policy Research Institute.
  • Handle: RePEc:uwo:epuwoc:20074
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    Keywords

    quality; signaling; pricing; advertising;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality
    • M37 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Marketing and Advertising - - - Advertising

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